The Return of Depression Economics

Paul Krugman argues that the idling of productive capacity in the world economy makes investment in public goods more likely to pay off now than at other times. While in good economic times credit is rapidly transferred to speculative growth opportunities, in bad economic times credit contracts, and much more production can be achieved with the same amount of wealth. Krugman calls this ‘Depression Economics,’ because it is true in bad economic times only.

Economist’s View: Krugman: What to Do
What to Do, by Paul Krugman, NY Review of Books: What the world needs right now is a rescue operation. The global credit system is in a state of paralysis, and a global slump is building momentum as I write this. Reform of the weaknesses that made this crisis possible is essential, but it can wait a little while. First, we need to deal with the clear and present danger. To do this, policymakers around the world need to do two things: get credit flowing again and prop up spending.

I believe not only that we’re living in a new era of depression economics, but also that John Maynard Keynes—the economist who made sense of the Great Depression—is now more relevant than ever. Keynes concluded his masterwork, The General Theory of Employment, Interest and Money, with a famous disquisition on the importance of economic ideas: “Soon or late, it is ideas, not vested interests, which are dangerous for good or evil.”

We can argue about whether that’s always true, but in times like these, it definitely is. The quintessential economic sentence is supposed to be “There is no free lunch”; it says that there are limited resources, that to have more of one thing you must accept less of another, that there is no gain without pain. Depression economics, however, is the study of situations where there is a free lunch, if we can only figure out how to get our hands on it, because there are unemployed resources that could be put to work. The true scarcity in Keynes’s world—and ours—was therefore not of resources, or even of virtue, but of understanding.

However, the market, not the government, picks winners through the savage mechanism of creative destruction. The government is not able to perform this role effectively.

Simply spending money on neat toys like new schools or bridges to nowhere is not the answer, because such project generate nothing and leave us with costs we will have to pay once the economy comes back.

Rather, we should focus on infrastructure spending that changes the system in ways favorable to us. The most obvious bad aspect of the system is that economic growth leads to greater consumption of oil and natural gas, which enrich bad states like Venezuela and Russia. Spending projects should focus on breaking this link, so that we can become wealth without them becoming powerful.

Projects like Solar Los Angeles, Windy Maine, and a million electric cars are part of the solution.

Heck, even the CEO of Poet Ethanol will be addressing a forum together with Tom Daschle and Jim Woolsey. The time to weaken the chains that bind us to Gap states like Russia and Venezuela is now.

8 thoughts on “The Return of Depression Economics”

  1. Rather, we should focus on infrastructure spending that changes the system in ways favorable to us.

    I hope this doesn’t mean expensive/inefficient solar panels covering all federal building and elsewhere.

    Solar isn’t ready yet.

    The best enabling thing would be to start building a network of smart power grids/ Some characteristics would be:

    - resilient…no systems shocks take it all down
    - better management capability
    - allow producers of electricity to plug in easily
    - extendability of the network

    If USGOV funds and forces the setup of not ready for prime time stuff, when the production ready stuff finally comes around, adaption will be slow because sadly most infrastructure purchase decisions are made poorly with the sunk cost fallacy full in play.

    Example: The poor state of network broadband in the US.

    BTW: What wrong with a bridge to Russia? I am only half joking. It would link up both South and North America with Asia and Europe by road and rail. I think businesses and entrepreneurs can find interesting things to do with that.

  2. Purpleslog,

    I hope this doesn’t mean expensive/inefficient solar panels covering all federal building and elsewhere.

    Solar isn’t ready yet.

    Perhaps not, but the purpose is not short-term cash-maximization but rather building an infrastructure. Photovoltaics are in the early adopter stage, and early adopers typically take the costs of the development the technology. Large-scale federal purchases of photovoltaics transfers the cost of development from the private sector to the public sector, which is appropriate for such a systemic change.

    The same is true of ethanol, btw.

    BTW: What wrong with a bridge to Russia? I am only half joking. It would link up both South and North America with Asia and Europe by road and rail. I think businesses and entrepreneurs can find interesting things to do with that.

    What would be the point of such a massive, expensive, and hard to maintain form of transportation between such distant points?

    What goods are so time-sensitive that they cannot be sent by ship
    (which is far cheaper) but so time-insensitive that they cannot be sent by plane (which s far faster), with the scalability of neither?

  3. Michael,

    Thanks for the link.

    The article’s sobering conclusion:

    If all else fails, it seems, the one sure way to secure solvency in the private and public sectors is to inflate away debts and buoy up asset prices. That nuclear option is the ultimate bail-out: rescuing the indebted by hurting those with savings. In essence, if not degree, it is not so different from conventional policy. Interest-rate cuts are a salve for debtors and a penalty on savers. Fiscal-stimulus schemes impose a cost on all taxpayers, even those well placed to endure a downturn. But the cost of a prolonged slump, in terms of idle resources, lost income, decaying skills and an erosion in the trust that keeps civil society going, would be far higher.

    We should hope that whatever money is borrowed / spent / printed in the coming months, it is done in a relatively wise manner to help us solve (or at least mitigate) long term problems, and not just reward friends of the powerful.

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